Inflationary shocks boost interest rate hike expectations, Japanese short-term government bond yields rise to multi-decade highs.

With the market's expectations of a recent hike by the Bank of Japan heating up, the two-year government bond yield in Japan has climbed to its highest level since 1996, while the five-year government bond yield has reached a historical high. Data shows that the two-year government bond yield, sensitive to monetary policy expectations, rose 1.5 basis points to 1.32% last Thursday, surpassing the previous high of 1.31% reached last month; the five-year government bond yield briefly rose 2.5 basis points to 1.74%, the highest level since the launch of bonds of that maturity in 2000. Previously, with the global bond market facing widespread selling due to the inflationary impact of oil price-driven inflation following the outbreak of the Middle East war, central banks around the world have issued warnings about sustained price pressures, which have pushed up short-term bond yields. Rinto Maruyama, a foreign exchange and interest rate strategist at Sumitomo Mitsui DS Securities, said, "This is the market pricing in a rate hike by the Bank of Japan in response to rising inflation. I believe that the increase in oil prices has raised expectations for terminal rates." Overnight index swaps indicate a 64% likelihood of a rate hike in April and an 89% likelihood of a rate hike in June. The rise in oil prices is also weighing on the Japanese yen, which is approaching the key level of 160 yen to the dollar. Bank of Japan Governor Haruhiko Kuroda retained the possibility of a rate hike in April after last week's policy meeting. Kuroda stated that despite remaining cautious due to market volatility and deteriorating risk sentiment, if the potential inflation trend were to persist, a rate hike cannot be ruled out even in the face of temporary economic pressure. Meanwhile, Japan's largest labor union organization, Rengo, reported that the average wage increase exceeded 5% for the third consecutive year. According to Rengo's preliminary statistics released on Monday, unions under the federation have reached an average pay raise agreement of 5.26% with employers, slightly lower than the initial report of 5.46% last year, but the basic wage increase averaged at 3.85%, higher than last year's 3.84%. Workers had previously demanded an overall pay raise of 5.94%. This indicates that inflation pressures are expected to persist and may prompt the central bank to further hike rates in the coming months. The Japanese government has promised subsidies to keep gasoline prices around 170 yen per liter and has allocated 800 billion yen from the budget reserve for the fiscal year 2025. While these measures may ease household burdens, they also highlight policy trade-offs as fiscal support could complicate the tightening path of the Bank of Japan. Ryutaro Kimura, a senior fixed income strategist at AXA Investment Managers, said, "More and more people are starting to believe that the Hatoyama government's approach of suppressing energy prices through subsidies is wrong, leading to increased expectations of an early rate hike by the Bank of Japan."